What’s the right price for your product? According to Steve Blank, it’s apparently $0. And it’s also $1 million. What?

Listen to this wonderful story to learn how Steve uses these two prices to create a bounding box around the highest price customers will pay for a product. And see why he thinks “It’s very easy to underprice your product… particularly if you’re an engineer.”

Steve’s story is about enterprise software, but you can apply these same techniques and thoughtful approach to almost any market — including the consumer Internet.

This is an excerpt from the fourth class of Steve’s customer development course. I’ve already taken the class, but I still subscribe to the Venture Hacks podcast and listen to it on my iPhone while I’m walking home from the gym.

“And she realized… she left money on the table.”

Steve Blank: Can I tell you a pricing story? When we starting Epiphany, I had no idea how to price enterprise software. There was one small problem, I had started an enterprise software company and never been in the business.

But, I had heard, and it actually was true, there was a woman named Sandy Kurtzig, who had started ASK Softwark. She was one of the first woman entrepreneurs, woman CEOs of a large corporation. And they were making software for IBM mainframes that was manufacturing software. Something called Manman, which I used in the late ’70s, early ’80s.

Since it was the first non-IBM enterprise software on IBM mainframes, [when] she got her first potential order, she didn’t know how to price it. It must have been back in the mid-’70s. She’s [with] this buyer, has a P.O. on his desk, negotiating pricing with Sandy.

The way she tells the story is, she didn’t know what to ask for it. But, the head of manufacturing told the buyer to go buy this damn thing. [He] didn’t care, [if] it was the world’s best piece of software. So, Sandy said she goes into the buyer who says, “How much is it?”

And Sandy gulped and picked the biggest number she thought anybody would ever rationally pay. And said, “$75,000″. And she said all the buyer did was write down $75,000.

And she realized, shit, she left money on the table. Sandy Kurtzig was awesome. And she said, “Per year.”

And the buyer wrote down, “Per year.”

And she went, oh, crap what else? She said, “There’s maintenance.”

He said, “How much?”

“25 percent per year.”

And he said, “That’s too much.”

She said, “15 percent.”

And he said, “OK.”

[Ed: This is called “flinch pricing.”]

So, enterprise software got priced at $75,000 per year, per module. Now, I have to tell you when I started at Epiphany I heard this story and someone said, “Steve, how much is your software?”

I said, “$75,000 per year, per module.”

Now, fast forward to about four years later. I’m leaving Epiphany, we’re about to go public like the next week. I did not want to be a Section 16B officer. I happened to be walking by a conference room. It must have been conference room 702B then. I think we had 800 people.

I happened to be hearing a pricing discussion. So, I kind of stand outside. And they are arguing about the pricing I had just made up as an entrepreneur, because I heard this war story. And somebody was screaming, “You can’t change the pricing. It was calculated by…”

“I was about to let it go for $75,000… By the time we walked out, we got an enterprise software order for about $1.2 million.”

Steve Blank: But the best Epiphany story, which I actually learned from a world class saleswoman named Gina Rulon-Miller. Her brother Todd was the first sales person at Netscape.

We went into Triple A, CSAA in San Francisco. It was going to be our first multi-million dollar customer. I went in with Gina. They loved our stuff, it really was going to do them a world of good. They said, how much is it?

And I was about to go, “$75,000…” And Gina goes, “Shut up I’m the salesperson.” She said, “A million dollars.”

And I went “…” Gina’s going, “Shut up. I’m the salesperson.”

And the guy looks at Gina and said, “Gina you’re out of your mind. We don’t pay more than $675,000.”

And Gina said, “All right. We’ll let you have it for $675,000.”

So, here was this software. I was about to let it go for $75,000, my first professional software salesperson had just gotten $675,000 and she did the same thing. And she said, instead of per year, she said, “But that’s for the base module. What other ones would you like?”

By the time we walked out, we got an enterprise software order for about $1.2 million. The point about pricing is, particularly if you are an engineer, it’s very easy to under price your product. Because you tend to value it on cost or need or competitive or whatever.

Bounding box pricing

Steve Blank: I, finally, in an almost every business I now work up what I call “bounding box” estimate, which is:

Now, for enterprise software does anybody know how you make money in enterprise software?

Yeah. Turns out for enterprise software it’s the number of seats you actually got deployed on. Yeah, you made money on maintenance later, whatever. But, if you just got deployed on ten seats in one department, it’s not really enterprise is it?

It’s like closet software, which I used to get stuck into. You actually want to come out of the closet and be deployed broadly, as broadly as you can. And the test was if it didn’t cost anything, what would it take to deploy it?

When I used to do that they said, “Well I didn’t really tell you, but the IT guy really needs to approve this through the…”

“Well, why didn’t you tell me that before?”

“Well, the product wasn’t free before. I thought we were just going to put it on ten seats.”

My point is going to zero flushes out a whole set of issues. Other times, I’ll go say to that same question, “How much is the product?”

“It’s a million dollars.”

“Steve, we’ve been talking for three months now. You know I don’t have a budget for a million bucks.”

And you get an answer sometimes like Gina did. “The most we pay for this type of software is $500,000.” Seriously. In a startup, you will find out by asking these questions continually, what the bounding box of your potential revenue is.

Do not be bound by what other people are charging. Anybody know where that science experiment that is being run today on a much lower price? Anybody know?

Anybody have the device in their pocket? iPhone. What’s the price of an iPhone app? Anybody know?

I don’t know. There are a bunch of sites out there with some iPhone revenue charts. It’s interesting. Go take a look at what the right pricing for iPhone apps are. My observation is people are running bounding box experiments real time. Real time.

Are they free and they drive other upgrades later or they charge you $9.99 and get real value now?

Interesting, but enterprise software firms are also in more of an oligopolistic situation – there’s only a limited number of those firms that can provide the solutions companies need.

I’m a freelance writer, and if I quoted an high price up front, most prospects would simply laugh and go elsewhere.

Like it or not, the scarcity of enterprise software firms, coupled with the switching costs you’d built up by already having gone through the extensive pre-sales process, gave you more power to dictate your prices.

I learned this lesson the hard way! It’s not about what the product is worth to you, it’s about what it’s worth to the buyer.

As an engineer I’d consider things like how long and how much time it took me to build and maintain. The customer doesn’t care about that — they care about what your product will get them that they don’t have.

Enterprise Software is a solution sale typically, and it all boils down to this. In order for an enterprise to buy something on this scale, it has to make the company money or save them money. The cost of the product then is set by either how much money it makes or saves the buyer. The VALUE of the product is the difference between the gain and the cost. If a company saves $1m because of using your product that cost $1m, then your product has no value. The bigger the difference the more highly valued it becomes and the more likely you will have customers as marketers working for you.

Your income though is separate from your value. Your income is set by how many people you provide value to. For example, iTunes saves me $10 because I don’t have to spend $12 for a CD that contains the two songs I want. Apple provided me a ton of value, but not a lot of actual income for Apple. But by offering that same value to millions of people, suddenly they have real income on a highly valued product.

This same concept holds true for enterprise selling. How many customers can you reach, how much value can you give them.

In order to close the deal though, you first and foremost have to attend to their needs. Thus your influence is determined by how well you look after the needs of others. Because of this a commodity seller will price his product as low as possible in order to get a transaction. A solution seller will meet with his customer, understand their needs and then have an opportunity for a more holistic satisfaction of his customer’s needs.

On a related note, someone I knew in the enterprise software space was trying to sell a sophisticated application for $25K at a time when competing solutions were $1-2M. He couldn’t get prospects to give him the time of day. Without changing anything else, he decided to start asking for $250-500K. Sales took off. He was an engineer at heart, and was pricing by what his company needed to cover costs. But buyers expected these types of solutions to be expensive. Understand your buyer and the value you bring, as Adam notes. It’s harder than just making up a number, but will generally give better results.